Let's Talk Money: TFSA is not taxed in estate settlement

Canada does not have an “estate” or “inheritance” tax on the value of one’s assets at death. Your assets are taxed as if you personally sold or liquidated your property at fair market value as of your date of death.

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Q: Being a single woman, I am interested in knowing if the capital gain in a TFSA is taxed in an estate. If it is, would it be advisable to withdraw the gain (if any) each year since it would be tax free?

A: The short answer is no, the capital gain in a TFSA is not taxed in an estate and so this is not a reason to withdraw the gain on an annual basis.

But your question bears further exploration about the benefits and uses of the Tax Free Savings Account (TFSA) now that this form of tax sheltering has been road-tested somewhat in the five years since its inauguration by the federal government in 2008.

The reason why the capital gain in your TFSA is not taxable upon your death is because it is not taxable during your life. Unlike the U.S., Canada does not have an “estate” or “inheritance” tax on the value of one’s assets at death. Instead, your assets are taxed as if you personally sold or liquidated your property at fair market value as of your date of death. Your registered pension and retirement assets become 100 per cent taxable as income unless your will provides for a tax-free rollover to a surviving spouse or other eligible dependent. The capital gain in your house is tax-free per the principal residence exemption. And the income and capital gains earned in your TFSA up to your date of death, being not taxable at withdrawal during your lifetime, are likewise free from being taxed.

The beneficiaries of your TFSA assets, however, may be taxed on income and capital gains accruing during the estate settlement process.

Indeed, it is in the ability to name beneficiaries to registered accounts that Quebec residents governed by the Civil Code differ from other Canadians governed by common law in their respective provinces. Common law allows accountholders to name a beneficiary directly on TFSA account-opening documents. Quebec Civil Code requires the naming of direct beneficiaries of registered accounts in the will.

Residents of other provinces are also able to name an eligible spouse as their TFSA “successor holder,” which allows for the deceased’s TFSA to be transferred intact to the spouse without affecting the size and contribution room of the survivor’s own account. This benefit is subject to conditions, however, as explained on the Canada Revenue Agency website: http://tinyurl.com/aqz4dft

But we are not that hard done by in Quebec. Under the Civil Code, if you have a will prepared by a notary (average cost less than $500), your estate does not pay probate fees that in common-law provinces can run into the thousands of dollars.

One good reason to withdraw from a TFSA, if you are careful about the timing of your withdrawals and contributions, is to further increase your eligible TFSA room by liquidating and withdrawing investments that made gains during one calendar year and recontributing the same amounts to your TFSA the next year. Again, you need to be careful about how you do this (i.e. read the tax rules and consult your financial institution) because if you mess up the timing, you will be charged a one-per-cent penalty by the CRA for excess contributions.

I would caution you as a single person not to be overly anxious about the size of your estate. Unless you have financially vulnerable dependents, your main objective should be to ensure your savings, including the TFSA, are maximized and used to provide you with a comfortable retirement with the care you may need during your later years.

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Canada does not have an “estate” or “inheritance” tax on the value of one’s assets at death. Your assets are taxed as if you personally sold or liquidated your property at fair market value as of your date of death.

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